Monday, December 10, 2012

Did risky mortgage lending cause the financial crisis?

1. A liquidity crunch or bank run, in which financial institutions all wanted to sell their long-term assets in order to pay off short-term liabilities at the same time, but couldn't.

2. A solvency crisis, in which so many systemically important financial institutions had made bad bets that their simultaneous failure threatened the health of the financial sector itself.

Both of these things involved risky mortgage lending. But risky mortgage lending, by itself, was not sufficient to cause either one of these. That's why I say that risky mortgage lending didn't cause the crisis.

Why not? Because in an efficient financial market, risk is fine. Risk is OK. In an efficient financial market, risk is priced. In an efficient financial market, if I buy a risky asset from you, I pay you less money because of the fact that I agree to take on more risk. (Paying less money up front means a higher expected return. So higher returns are my compensation for taking on more risk.)

What happened in the financial crisis was that risk was mispriced. People underestimated the risk of mortgages, mortgage-backed bonds, derivatives of mortgage-backed bonds (CDOs), insurance on mortgage backed bonds (CDS), commercial paper of banks that owned a bunch of mortgage-backed bonds, repurchase agreements with banks that owned a bunch of mortgage-backed bonds etc. Because they underestimated the risk of these things, they paid too much for them. This caused crisis (2), the solvency crisis, which hobbled our banks for years. And realization of crisis (2) caused crisis (1).

If there had been less risky lending, would people have underestimated these risks as much as they did? Maybe, maybe not. But whether or not they would have, we know that if the financial system had worked like it should, then there would not have been such a systematic underpricing of risk.

So risky mortgage lending didn't cause the crisis. What (partially) caused the crisis was risky mortgage lending being mistaken for non-risky mortgage lending, by people who ought to have known better.

Which brings me to the Community Reinvestment Act. Via Tyler Cowen, here is an NBER working paper that shows that the CRA made banks take on riskier portfolios of mortgage loans than they otherwise would have.

Does this mean that the CRA contributed to the financial crisis? No. Because the CRA existed since 1977, and the U.S. housing bubble only began in the 2000s. If three decades was not enough for the financial market to figure out that CRA mortgages are riskier than other mortgages, then the market is grossly inefficient, and crises will tend to form even with no CRA. And if in those three decades the market did figure out that CRA mortgages were riskier, then the CRA risk described in the paper was properly priced into all the MBS, CDOs, CDS, asset-backed commercial paper, etc.

In other words, the CRA made have caused more risky mortgages to be born, but the banks should have known that and hedged their bets accordingly. Either they did, and the root cause of the financial crisis was the mispricing of non-CRA risks (I suspect this is the case), or else they didn't, and thus the financial system was broken for a long, long time.

Either way, we shouldn't blame the CRA.

Update: Yes, I know there are reasons to doubt this study, and to think that the CRA didn't even cause much of the increase in risky lending. But the point of this post is: Even if it did, that doesn't mean it contributed to the financial crisis!

106 comments:

It's also worth noting that the worse offenders either weren't even subject to the CRA, or if they were, did much more lending than required by the CRA.

To read Tyler Cowen is to understand that there are two sides to Dr. Cowen, the very bright quasi-prodigy who has seems to have trouble feeling empathy (maybe something on the autism spectrum? Maybe mild sociopathy?), but has good mind when it comes to thinking differently and having an interesting perspective. Then there's the Tyler GMU/Mercatus Center side of Tyler were huge amounts of Koch brothers money keeps the paychecks coming and there's an implicit, if not explicit, agreement to push research that essentially amounts to, "Gov't programs and regulations, especially those meant to benefit the poor or protect the environment, are the root of all of America's economic problems." Tyler's trouble with empathy (and his libertarian beliefs, which are likely linked), make him a good fit for Mercatus/GMU.

Anyway, when you see a working paper from Tyler that feeds the Tea Party myth that the cause of the Crisis was good smart bankers being forced to lend to degenerate, poor, minority borrowers, then you can say, "Oh, it's Mercatus Tyler, not "Eat like an Economist" Tyler."

Through structured finance, roughly 80% of dollar subprime issuance was rendered AA/AAA. An alien visitor in 2008 could have been excused for thinking the whole point of subprime lending was to significantly increase the supply of lowest-risk loans. It was these AA and AAA tranches that were severely mispriced. Gorton describes how a classic lemons problem created by doubts over the integrity of AAA assets began in 2007 and culminated in the GFC.

The question is why shadow banks -- the source of AA/AAA demand -- exploded in growth during the boom years. This "safe asset demand" arose from outsized, levered duration bets ("carry trades") made by the shadow banking system. These bets were fueled by the Fed's unprecedented 2002-2005 commitment to keep interest rate volatility low. Of course, none of that had anything to do with the CRA.

Let us assume a 50% default rate i.e. that half of borrowers stop pay their mortgage. Let us also assume a 50% recovery rate, i.e. that, after a foreclosure, bank gets back only a half of a loan amount. In this case 75% of total loan amount (1/2 + 1/2*1/2) will be returned.

The 75% is not much different from 80% weighting of AAA tranche produced by elaborate models. So, 80% did not look ridiculous - it passed a smell test.

Who would imagine before the crisis that it is possible that more than 50% of borrowers will default, that foreclosures will take years, and that homes prices will fell more than by 50% - or that home will be abandoned and rot ...

Now it is very conceivable - though I am far from sure that the black scenario actually happened countrywide (pun intended) in US as opposed to select, most affected metropolitan areas.

The CRA applies only to loans backed by the FDIC. Since almost 85% of the mortgages that went bad were generated by companies such as Ameriquest and Countrywide that weren't covered by the FDIC it is almost silly to even mention the CRA when commented on the causes of the crisis.

"What (partially) caused the crisis was risky mortgage lending being mistaken for non-risky mortgage lending, by people who ought to have known better."

Its well documented that much of the MBS that were compiled consisted of a mix of sub-prime and non-risky mortgages. This was a deliberate practice whereby banks diluted the quality of the assets while maintaining AAA credit ratings. It was at best a shady practice. So no it wasnt just incompetence, and we shouldnt forget that. The people who did this should have been held to account and prosecuted.

I agree except for the "It was at best a shady practice" part. The blame here should primarily lie on the rating agencies, not the financial institutions. The rating agencies haven't received their fair share (which, imo, should be the largest share).

It was collusion and blinkers-on denial for greeds sake just as it was with Madoff...

If a huge investment firm like Goldman is buying and selling this crap and also has mortgage servicers (it sold that part as it was being investigated for other fraud they got hand slapped for) then of course it was collusion.

Greed ensured Mers took over for proper documents and mortgage notes going through the process and ensured no one signature. The list of complicit are those who gained from day one... from the home assessors right on up. I n Florida it was like a mob run enterprise! And yet few were charged...

The ratings agencies knew they were rating junk as AAA... but they were paid by the banks (inherent conflict of interest) and the banks threatened to withdraw their payments (go to the competitor) if the ratings agencies didn't do what the banks asked.

To be fair to the ratings agencies, Fitch and Best usually refused to rate the securitized junk. S&P and Moody said "Sure, AAA, how much do you want to pay for that?"

Yep, collusion. The root of the thievery was in operations like Countrywide, which infected all of the major banks, but there were a lot of other organizations bribed to go along, including title insurers and ratings agencies and of course regulators and politicians. Bill Black has the best description: "Criminogenic environment"

"In other words, the CRA made have caused more risky mortgages to be born, but the banks should have known that and hedged their bets accordingly. Either they did, and the root cause of the financial crisis was the mispricing of non-CRA risks (I suspect this is the case), or else they didn't, and thus the financial system was broken for a long, long time."

A couple of points.1) The vast majority of the AAA structured mortgage securities created prior to the crisis in fact did not experience defaults. 2) Essentially all of the bailouts in the U.S. ended up turning a profit for the government

Taken together, these points argue that there was not necessarily even widespread mispricing of mortgage risk. In hindsight, a better explanation is that there was *some* mispricing of risk, the extent of which was not clear at the time. Fears that losses were greater than they really wore led to a classic liquidity crisis, driving asset prices far below fundamental value and causing widespread financial distress.

I have always appreciated the CRA caused Financial Crisis argument as being like the argument that since the Roman Empire tolerated homosexuals, God punished them by destroying the empire - 1000-odd years later.

Ok. So forcing banks to make loans to people who did not deserve it did not cause the crisis. So What did ? Greed ? Hey people have been greedy since Adam and Eve. Even according to God. So ? Liberals ? You gotta be more convincing. And it is not a direct CRA only type effect here. From the 1990s government started becoming more and more harsh on the banks to push loans to minorities and poorer people.

Of course intelligent and post ante unintelligent securitization of loans became an industry. But remember at the source banks were not willing to take risks giving loans to the government's chosen vote banks initially. Anyway you see it this was a signal from the Government that we are asking you to do this so we will save you eventually if something goes wrong. And that is what exactly happened. NO one mispriced the risk as much as you think. They just knew the Government would save them in the worst case scenario. Bot the government and the industry folks know this. Only the liberal Professor types don't get it anyway. Who cares.

Sorry dear Liberals. Economically it is pretty obvious what the primary "source" of this crisis is. "Force" is what distorts a market more than "greed".

I thought we are talking about What got them there. At the source whichever way you see it, they took more risk than they could manage. Exactly their prognosis when they did not want to give out those loans initially. But once forced they squirmed out a way and of course you can blame them for getting carried away. But they could argue logically that the government got involved so they were going to save us anyway. I am only talking about the "source". It has to be the "Force" from the government.

Personally I think people don't discuss this because it is nearly obvious and there is nothing we can do about such things in the future. Because the governments will always continue to use force as they wish. Hence only the errors that come after count. That much I can understand.

Just to add to my previous comment. The biggest thinking error is assuming you can price a loan you DO NOT want to give. Typical errors made by mediocre folks who rarely think. You do not want to give a loan because you cannot price it. But now since you have been forced to make those loans, you either increase the cost of other loans or find new innovative solutions to pass on the risks to other people who are bigger fools than you. Luckily there were government backed agencies exactly doing this. Tagging themselves as that bigger fool. Those in industry already know that the Government (and Liberal Professors) = bigger fool anyway.

But you've provided scant evidence that any bank was giving loans they didn't want to give. Where are the bankers who complained about this? And why didn't they see the crisis coming? The complaints about the CRA come exclusively from pundits, not bankers, and the complaints didn't start coming until after the crash. And as others have noted, banks subject to CRA requirements did less risky lending.

What more evidence do you want? The very meaning of CRA and the well known government push all imply banks had to give loans which they earlier did not consider worthy. If CRA != 0 implies more bad loans than before. period. Though I suggest if you look for that data with an unbiased mind you will see it. Like this paper shows the analysis for data beyond 1999. Remember Clinton repealed the Glass-S act in 1999 and said this will increase the scope of CRA. Of course he was licensing banks to change their risk models to accommodate the useless loans the government was pushing. Everywhere if you shut your liberal brain you will see the connection. Because it is there so glaringly it seems to hurt liberals more. I only agree that an Economist cannot say the Government is at fault because that is its very job. An Economist has to design a solution which takes its stupidity into account. At that level clearly most banks failed. But not all remember.

The remaining is your prototypical denialist stupid argument. That banks didn't see it coming. Like they are born geniuses with the abilities of Nostradamus. Even today you have different people predicting different things. That is how the economy works. If everyone knew which direction we are headed we get a financial crisis.

Anon, could you explain how the CRA and the repeal of the Glass-S act fuelled the property booms, crashes and resulting banking crises in the UK and Ireland?

As someone with a (very) small part in mopping up that mess, I can assure you that US backed institutions like GMAC were happy to make loans in the UK (and then bundle and resell them) to borrowers who quite obviously couldn't pay them - no CRA needed.

You guys are making a huge mistake in thinking about the chronology here. Circa 1990 and before, Banks were as reluctant as ever to give loans to people with no guaranteed incomes regardless of whether they were white black or hispanic. But now for obvious reasons a larger part of these folks were minorities. So When Clinton comes to power he says Hey this is unfair you are specifically NOT giving these people loans. Look here, the percentage of minorities not receiving loans is higher. So you guys better change your ways and here I'm making laws to make that happen.

What are now banks supposed to do? They did business the normal way and now you are telling them this "normal" way doesn't work for my election winning chances so you have to change them. Beyond this simple logic if you demand "evidence" you are basically fooling yourself. You can go check the evidence is what I said. You will find loans to these categories of people without regular incomes went on increasing as Congress kept on putting the pressure. Your favorite liberal champion Obama was actually part of such a lawsuit which punished certain banks for not making the loans he thought "ought" to be made.

So coming back, the chronological error is mistaking the European crisis with the center of the real financial crisis. Once American demand falls and international bank risk models go haywire everything starts going wrong. Heck the Asian stock markets too fell over 100% during the crisis. We are discussing what started the dominoes rolling. The source of that domino rolling is the "Force" used by the government to push banks to MAKE loans they DID NOT believe were justified by their risk models.

And now you blame them for changing their risk models. You are liberal. And you are taking America down with you. Good Luck

Anon, the original purpose of the CRA was to mitigate the practice of redlining. See here,

For example, in Atlanta in the 1980s, a Pulitzer Prize-winning series of articles by investigative-reporter Bill Dedman showed that banks would often lend to lower-income whites but not to middle- or upper-income blacks.

Your broadsides are nothing if not prima facia evidence of a closed mind.

@mattski: Show me that evidence. Remember you are telling us that multiple banks let go of customers who had capacity to make them a profit as each loan successfully paid back equals profits for the banks. So you are saying ALL the banks in America let go of profit opportunities purely because they did not like minorities. I am not saying it is not possible but I'm saying that is unlikely. And at best could only be partially true. There are very specific reasons for refusing someone a loan especially if they are low income. For example they look at previous records. They look at other assets owned by the families, stability, criminal record etc etc. So it is entirely possible purely due to this analysis, lesser minorities got loans than others. It just looked bad to the intellectual fools out there who only look at the race and cry WOLF!

And CRA as someone pointed is a red herring. It is a small sample of all the government pushing that happened after 1990s to push loans to those who did not deserve it. Remember my only argument is that this is the source of the crisis. It needed a lot of other things to get going. The entire risk model, set of financial innovations to cover this unbearable risk all had to happen for the crisis to happen. The US government wanted to push cash to poorer people because the employment opportunities were not enough. This remains though the main cause on the supply side. There are arguments that NGDP targetting could have averted the crisis etc. Those are all good arguments but remain a separate debate.

@JzB Those are the kind of trivialities you play with when you have nothing to push your case. I said the evidence is there if you look for it. You skipped mentioning that. It is there overwhelmingly. The case made by the liberals is that those loans were necessary for reducing inequality. They already sort of admit they may not have deserved them etc. Well you just found out forcibly reducing inequality has a cost and some of them can be extremely destructive. Not that I expect most liberals to learn any lessons from this because you are going to find ways to continue not believing in this.

The answer was to make it profitable by slicing and dicing them and shorting it, selling it to to each other to further hide that MERS was a farce and that the assessments were a sham to keep prices inflated, and hide the toxic hot potato in long prospectuses to be dumped eventually on those who trusted that large Investment firms would never sell them junk...

There's another factor here. Historically, the U.S. government has bailed out troubled financial institutions, going back to Continental Illinois. The banks were taking on more risk because they knew implicitly that they would be bailed out by the USG if they failed; i.e., the moral hazard problem. These loans were priced correctly, in a way - the risk was not being assumed by the banks, it was being assumed by the taxpayer, at least indirectly.

With the exception of Lehman, the banks were right - they all got bailouts.

The other factor is Fannie/Freddie's role. They were implicitly guaranteeing mortgages which were bad (Countrywide had been pushing garbage mortgages on them for years) and the taxpayers have been on the hook since Fannie and Freddie went into conservatorship.

In any case, even if we set aside CRA, it is safe to say that overall government policies which encouraged homeownership certainly distorted the housing market. SInce loans were easy to get, housing prices skyrocketed and the wealth effect took over. It will take years to correct.

I'm not certain anything was mispriced, and I'm not sure there's a way we can know that in hindsight.

Let's say I invest my portfolio mostly in truly safe assets and 5% in asset X, which has an excellent return but has a 5% chance of becoming worthless in the next decade. X is just one asset of many in asset class Y, all of which have similar risk characteristics. Now let's consider two possibilities for this risk: it is independent of the risk of other assets like it, or it is systemic risk, meaning that all the assets will do well or all will become worthless. Note the way that I've described my portfolio, it doesn't make a difference to my investment decision which is the case.

In the independent risk case, we will see in hindsight that in fact 5% of assets in class Y failed, and therefore they were priced correctly. In the systemic case, however, we will either see that everyone is making above market returns, or we'll see a great financial crash. But if the latter happens, do we know that we mis-estimated the risk and mispriced the asset? Mind you I suspect that banks did underestimate the risk of a housing crash, but I'm not sure how I could prove this because I don't know even now what the probability of the crash happening was.

The other problem with this is the suggestion that correctly priced risk is A-OK, when correctly priced systemic risk may not be. Is the problem with Hurricane Katrina that the levees were overdue for maintenance, or that the price of homes in New Orleans pre-storm was too high? Lowering systemic risk in the economy is worth doing even if it is being correctly priced.

Even a 'mispriced' risk is a priced risk although not at its 'correct' price.

I do have a some problems using the term 'mispriced'. First of all, you have only one sample path and that path turns out to be a particular bad one. However, one could also imagine that there exists a sample path in which there is no financial crisis and the banks didn't need a bailout.

Second, the term 'mispriced' implies that there exists a true probability distribution of all future events and banks (and everyone else) knew the true distribution. However, given that the financial instruments were relatively new there exists only a limited amount information. So reasonable people could disagree about the possibility of events. Furthermore, even with an infinite amount of data people can still disagree.

It's an interesting point in a general sense. But I think you can safely argue that there were huge quantities of investment products that were mis-rated by the ratings agencies according to their own stated risk evaluation models. If they aren't rated properly, they aren't priced properly, therefore they're mispriced.

As someone who works in the industry, I would like to correct some of the common misperceptions:

First, the phrase "by people who ought to have known better" is often repeated and refers commonly to bankers who made and syndicated loans. Let me assure you for the most part that they did know the potential outcomes. They also knew that they could sell these loans on profitably and, therefore, competitive dynamics meant the loans would be made (if not by me, by my competitor). Also, individual bankers do not think about or care that they "will be bailed out" as they are not individually bailed out. The leadership of the banks most effected lost substantial personal net worth that will never be recovered (read Jimmy Cayne).

The people they sold these loans to were largely institutions like insurance companies and non-us banks that liked the combination of relatively high yield and AAA ratings (loved by RBC and Basel models). These people, their regulators and the ratings agencies are the ones who "should have known better".

Lastly, Arthur is right. None of the models used to price these securities (or many other securities for that matter) anticipated that there was any significant probability of a 10% decline in NGDP, which led to 30+% declines in home prices and substantial defaults on even conventional mortgages. However, I am two minds about whether we should label this as a monetary policy failure. In my view, monetary authorities in democracies will always respond slowly to conditions that go beyond the norm because they are worried about their legitimacy and will need time to build concensus to act. What that means to me is that a big, big part of the failure was regulatory, as in we allowed the development of fragile (over leveraged if you will) financial institutions although we had all the regulatory authority (prior to Dodd-Frank) to prevent it.

Good summary, but the fact that the crisis was caused by failure to assess risk (and so calculate an appropriate risk premium for financial instruments) has been the consensus among finance academics since at least 2009. I'm more curious about the "why" ... e.g. is there just too much capital and not enough opportunity to earn a return, which in turn artificially, and dangerously, lowers the risk premium?

It frustrates me that crap like this is written by serious economists, and published by the NBER. Where is the theory behind why the CRA would lead to riskier loans? Without a theory the exercise is simple data-fishing.

As far as the crisis is concerned, in the beginning of the crisis the vast majority of delinquencies were among subprime loans, and the majority of subprime lenders were not bound by the CRA since they were not commercial banks. It is like attributing the lung cancer of a chain-smoker to spending 7 days in a city with high air pollution. Give me a break!

It is nice to see the idea in "print" that neither the amount or type of debt was the problem but rather the price. This is an idea with which I entirely agree. Now the issue ahead of us is amount of government debt (at least until the government start bailing out more private debt again, at which point that will also be government debt). So the amount of government debt is not a risk in and of itself (since debt = assets we (largely) pay to ourselves). But rather the risk is that the pricing is incorrect (ie does not predict the future monetary path correctly). And the larger the debt, the more risk that if the price is off, there will be a systemic problem.

Why not throw most of the rationale out and focus on the feverish focus on the trading short. When any party has a substantial amount to gain at everyone else's expense, of course they will do whatever is in their power to maximize that. Add to the mix the tendency for herd to act together or for lemmings to do what they do and we have a situation that is ripe for overreaction. Liken it to someone yelling fire in a crowded auditorium and the shorts as having locked the majority of the exits... I suppose in retrospect we can always say "well, we didn't assess the risks of having so many people in the auditorium at the same time" when clearly, even in a situation where the shorts didn't lock the other exits casualties from a false alarm would be outsized...

point being above that panics can compound the perception of risk thus making otherwise unwanted events more devastating. Traders are not compensated to trade to policy solutions, rather they're compensated on how well they can capitalise on sentiment and perception... This in and of itself can be a recipe for disaster...

Bad monetary policy casued the financial crisis. Excessively low interests rates caused the financial crisis. It was never liquidity risk. It was always counterparty risk. We didn't get this. Never. It was not a market failure. It was a policy failure. The rest was just consequences, catastrophic consequences.

Any US specific theory should be viewed pretty skeptically. Even one that was more rigorous than this. It would have to explain why the UK, Ireland, Iceland, Spain, Hungary, Greece and Portugal had a crisis while Germany, Japan, Australia, Sweden, Korea, and Canada did not.

The one of best inoculation against a 2000's financial crisis seems to have been to have had a financial crisis in the 1990's. It's not perfect, but has substantially more validity than any US specific institutional explanation. But, it's essentially a financial instability hypotheses argument on an EMH. Alan Taylor has done some fantastic empirical work in this area.

Here's my basic take on the causes of this financial crisis: It stems from 2 separate flaws in capitalism.

1. The mortgage brokers (e.g. Countrywide) realized they could take advantage of information asymmetry (that is, the seller knows more about what they're selling than the buyer) on both sides of the transaction. They sold the homeowner a lousy mortgage the homeowner couldn't possibly understand, and then carefully hid what these mortgages actually were so they could sell investors a AAA-rated MBS that they couldn't possibly understand. And by the time that anyone else involved in the transaction realized what was going on, it was too late for them to get out of the deal. They had the information advantage when dealing with both homeowners and investors, and profited from it.

2. The other fundamental flaw is in the limited-liability corporation: The individual salesman is motivated to maximize short-term sales and hide any risks to the company from his bosses, because doing that will maximize his personal compensation. He risks nothing except a future career, but if he's made, say, $10 million before he's caught, that only means that he might have to live off of a mere $400K a year the rest of his life without even working.

As someone who has had 18 years of regulatory advice with respect to CRA and HMDA I can tell you the Regulation definitely had a role in the crisis (although by itself the Regulation's impact would not have been as great when it effects were combined with other market changes such as mortgage-backed securities).

To begin with, although CRA's genesis was in 1977 it was not aggressively enforced for the first 20 years. Moreover, CRA itself was dramatically overhauled in 1995 and the reform was based on changing CRA performance from subjective measurements to quantitative standards. These quantitative standards specifically included lending in low and moderate-income tracts and to low and moderate-income people. This was the first time objective and measurable performance standards were included in CRA. Before that CRA ratings were based on 12 subjective performance standards. This started to impact lending in the late 1990's.

It is true that much high risk lending was generated by non-CRA regulated lenders. But what is overlooked is that many of those high risk loans to low and moderate-income borrowers and in low and moderate-income areas were purchased by CRA-regulated lenders who were motivated to purchase these loans because of the impact on their CRA performance (CRA recognizes not only loans originated but loans purchased as well). Furthermore, many of the non-CRA regulated lenders were affiliated with CRA-regulated lenders who had the elective under the Regulation to include the loans made by their affiliates. I personally reviewed the CRA performance evaluations of many of these large banks who had non-CRA regulated affiliates and many of those banks did exercise their elective to include the loans originated by non-CRA regulated affiliates in their CRA performance evaluations. So loans made by lenders not subject to CRA did get incorporated into the CRA performance evaluations of CRA-regulated lenders.

Another way the lending activities of non-CRA regulated lenders was via what is known as Community Development Investments. Under CRA banks are examined not only for their lending but for their investing too. And pools of mortgage-backed securities made to low and moderate-income borrowers or in low or moderate-income areas were attractive as CRA Community Development investments.

I am only just beginning to recap the way CRA did impact mortgage activities. I have never seen a comprehensive study that has taken into account the multifarious ways in which loans made by non-CRA regulated lenders affected regulated banks as I have explained above. Many bankers were lulled into a false sense of security when purchasing or investing in mortgage pools. The original lenders made bundles of money packaging their loans and selling them through different channels to CRA-regulated lenders who were motivated by the CRA implications of buying or investing in those loans. And I can tell you those loans were often sold at a premium because of the CRA benefits. There is much more I could say. But this ought to get some people examining the issue from a broader and more comprehensive perspective that will help to identify and measure the true impact of CRA on mortgage lending and investing and its role in the financial markets crisis of 2008.

Angelo Mozilo: “The loans were originated through our channels with serious disregard for process, compliance with guidelines…we delivered loans with deficient documentation, did not respond timely in correcting those deficiencies”

You're trying too hard to make a fine distinction that is unnecessary to make: that fraudulent loans didn't cause the problem: people not realizing they were fraudulent loans were the problem. But fraudulent loans that are easy to spot aren't very good fraudulent loans.

When vile fraudsters call up old people and trick them out of their life savings ("Your nephew is in jail, and needs bail and a lawyer--give me your bank account info quick!"), are the old people at fault for not realizing the fraud? No, the fraudsters are at fault. The people being defrauded are partially to blame only to the extent their own greed plays into their part of the fraud (e.g., Nigerian scams).

I just want to share an outsourced accounting department that helps small businesses in Australia not just on finances and taxes, but also on growing their businesses. An accounting firm that has great cloud accountants that use Xero accounting software for bookkeeping services in Australia. Please feel free to visit Accountsteam.com.au and know more about this accounting firm.

A very short, concise and accurate description of the cause of the financial crisis by Noah.

He does leave out that the mispricing of the mortgages was intentional on the part of the investment banks, but despite the obvious truth of that, it is not easy to prove.

The same exact thing happened at the same exact time in auto finance. Curiously enough, many of the same investment banks were involved in that also. All of the main sub prime auto banks took tremendous losses, as repos happened before they could even sell off the ABSs, or happened fast enough that the banks took the hit instead of the investors.

HSBS, AmeriCredit and Cap One were the big guys. HSBC went under(the auto part); AmeriCredit had to sell off just about everything to survive(and is now being bought out); and Cap One just squeezed through. There are another 5 or 10 that just disappeared.

Often misunderstood is that people think subprime financing is a bad thing. It is not. It gives people the chance(at a price) to rebuild their life from past mistakes. The problem is that when it is intentionally mispriced(not to mention intentionally misrated) huge losses will occur. It is just arithmetic.

And all of the banks knew it. But they also knew that they could artificially create incredible demand with their fake AAA paper. And they knew that AAA paper attracted huge investment dollars from sources whose portfolios had to be all AAA or a huge % of their portfolios had to be AAA(insurance companies, pension funds, etc.).

Add in the fact that AAA paper can be leveraged much higher than other paper, and you have the whole story of the financial crisis.

Show me one piece of evidence where the "mispricing" of risk was intentional across the board and then I will no longer complain of any other cause behind the financial crisis. Post ante any error you can cry was intentional. But when you have government agencies sitting buying shit loans then your pricing model is not intentionally mispriced. The government was the source of that pricing model.

Tell me where the stock market will go tomorrow and in the next few months ? What should be the interest rate I should get a loan, At what price should I give a loan ? No one does all these things intentionally right or wrong or mis-anything. They see data, put some over worked MBAs and you get a price for the risk through some vague mathematical models. Concepts such as intentional mispricing is the classic bullshit from brainless liberals. Because that is just post ante analysis. When people get their models wrong you cry "intentional". When people are unwilling to bet on some low income idiots you cry racist. Well you are getting the long term fallout of thinking such as yours. And guess what it can only get worse.

That shows how pathetic your actual level of knowledge is. My dear liberal genius have you actually gone through any of those securitization models before making your prototypical final judgement on someone's racism, stupidity, credibility and morality and intentional mispricing ?

I suggest you look at maybe the easiest piece of such a securitized bunch of loans. You will find every single great Economist and Finance big brain thinking highly of these models at least while they were widely used. It was and still is a theoretically correct way of designing things. To give you a headstart assume you have past data (which is what all experts have to work a model) and find 5 loans out of 100 go bad from a certain known section of loans. So how did they build a tranch. They put the income from the top 50 of these loans in the AAA tranche. The next set in the BBB type and so on. There are many such models. It is as AAA as you are theoretically allowed to design. For example Greece was a developed country not so long ago. So you assume the Government bonds from Greece is as good as gold and mark as AAA. But Greece is gone forever what happens to their AAA? Oh Well they mispriced it intentionally ofcourse back then. I mean your stupidity does not piss me of so much as the way you want to prove your point without knowing any details. It is pathetic. Maybe come back after understanding some of the mathematics of the design used here. Everyone makes errors. You do not randomly say everyone "mispriced" without at least being an expert in these areas.

The idea is that they ignored the models. They ignored their experience. Geez, did you read the quote from Mozilo I posted?

I have not called you a racist, you are just misinformed.

Ignore the reality and concentrate on pure common sense. If low income borrowers forced on the banks by the government(zip code driven) caused the bubble, why didn't the bubble happen in those zip codes?

The banks caused the bubble all by themselves, and on the contrary, the consumers that took advantage of it were not poor, but were speculators.

"The charts reveal some astonishing facts. At the peak of the boom in 2006, over a third of all U.S. home purchase lending was made to people who already owned at least one house. In the four states with the most pronounced housing cycles, the investor share was nearly half—45 percent. Investor shares roughly doubled between 2000 and 2006. While some of these loans went to borrowers with “just” two homes, the increase in percentage terms is largest among those owning three or more properties. In 2006, Arizona, California, Florida, and Nevada investors owning three or more properties were responsible for nearly 20 percent of originations, almost triple their share in 2000."

Now, take those numbers by the Fed and add in that many buyers lied about the use of their properties, so the Fed's numbers are understated.

Of course, the Big Lie proponents will come back with comments like yours. None of them will contain a the number of originations as proof. None of them will contain a actual number of foreclosures. All of them will just contain an ideology.

And us "liberals" are expected to accept that ideology as opposed to actual facts.

HaHa! Not a single piece of information that you provide is contrary to expectations. What is our argument here? What is the specific change that triggered all the stages that came next. As I said pushing bank loans for idiots was NOT the only reason. A lot of things had to be changed for that to go through. And that is what the government did. If you see Clinton's statement (available even on wiki). He mentions removing Glass Steagal will help expand CRA et al. See once new risk models are built using securitization ideas, local problems can become global problems. Of course I'm not denying that. But Why did government allow those risk models ? Because the banks told them, look you want us to give loans to idiots we cannot using the current risk model.

Why did house prices keep skyrocketing ? Because now even idiots entered the market with bank generated money. Why should not speculators not buy more houses as investment ? Are they idiots ? They see house prices going up year on year and they take a chance in this mayhem. You can call them wrong only post ante but ex ante their decision was fair as they saw a secular rise in home prices. So you see you are mixing data from random places and are unable to isolate the initial stages of the crisis.

The point is when you break the normal chain of how things work. Like nature designed them. Nature did not design unemployed low IQ idiots to get houses and continue to breed like mad. Instead of creating employment opportunities Government decided giving them free money was the easy route. But Once you change this cycle, shit happens. Suddenly the majority White vote cannot elect a President they want. Suddenly people begin to demand more and more from the government. Suddenly Washington DC starts becoming richer and richer full of lobbying firms. Suddenly companies realize it is better to pay of lobbying firms than start another manufacturing plant to get regulations that suit them. You see this is not racist or not racist. This is just a fact. It is this fact that you are unwilling to accept.

Anonymous, the last post shows the level of your ignorance of basic economics. One does not have to be a liberal to object to the hate-filled "the world is flat" rhetoric of ideologues like you. I am not a liberal, but I would much rather side with liberals like EMichael than with stupidity. Oh, and the last sane person out of the GOP please turn off the light!

On substance, here are a few facts:-The CRA covers only commercial banks and thrifts. Sub-prime lenders, the root of the problem, are not covered. Yes, some of them were affiliated with banks that were covered, but they were a minority.-Borrowers under the CRA still had to meet the same criteria in terms of income, employment, etc. like any one else. So where is the theoretical link of why CRA loans would be riskier? Could it be that the borrower was most likely black? I don't like to accuse people of racism, but...-"The current crisis is rooted in the poor performance of mortgage loans made between 2005 and 2007." However, "the CRA rules and enforcement process have not changed substantively since 1995." Here is the study: http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4136-If the CRA is to blame for the housing bubble, how does one explain the same bubble in Ireland or Spain? These countries do not have a CRA.-Those who blame the credit expansion to U.S. monetary policy should really read Bernanke's speech on the global saving glut all the way from 2005. Here is the link: http://www.federalreserve.gov/boarddocs/speeches/2005/200503102/

Did the facts mentioned in the paper here do anything to change your mind ? Your cousins thought so what if the data from 1999 upto the crisis shows a strong correlation between CRA and the problem. CRA was 1977. Don't you get it. Facts do not matter when it comes to the ideology of idiots. On both sides. The only thing that troubles the brain is simple logic and philosophy and that is why you want to cling to only data but not willing to take into account the data you already have.

I don't know how that study contradicts what I am saying. If after 1999 all hell broke lose in the way bank loans got made. If Clinton says specifically that this new law is done for ENHANCING CRA and such activity of spreading the loans everywhere What are you trying to contradict that with ?

As I said you are confusing what I am specifically saying as the SOURCE of the troubles. By the time the last domino falls no one can even see the first domino. It does not matter if CRA was a small percentage AND all other government pushes contributed to another small percentage. They started the fundamental distortion of the way banks work. A completely new risk model, new forms of risky innovation etc etc. This triggers off excesses everywhere. As I said CRA is the red herring here. It is the systematic way the government made changes to how things worked to get cash in the hands of their favorite vote banks. On both sides. They did not attempt to solve the real problem of underlying job creation but stuck to easy ways of distributing cash.

And this is not some brilliant idea by an anonymous buffoon. These is the prognosis of one of the very few guys who saw the problem 3 years in advance. AND is not known to be the kind of Roubini type guy who just cry WOLF all the time.

"I don't know how that study contradicts what I am saying. If after 1999 all hell broke lose in the way bank loans got made. If Clinton says specifically that this new law is done for ENHANCING CRA and such activity of spreading the loans everywhere What are you trying to contradict that with ?"

Umm, that the CRA was not enhanced?

Can you giv me the author of this "brilliant idea"?

Please don't if his name is Pinto, or Wallison or Cassidy. I have lost enough brain cells reading those buffoons.

And I will say, this Domino Theory is priceless. Stupid, but priceless.

I see this graph in your favorite paper which shows % CRA went down after 1999. I'm guessing that is what you got off on. So Hey all is well and good eh. Now use Domino Theory. What are the many ways that can happen ? 1. All CRA fell down suddenly even after Clinton specifically set rules to increase CRA type focus. 2. All kinds of loans went up after all the drastic changes the government made. The UNINTENDED CONSEQUENCES. Governments favorite disaster creating mechanism. Now the securitization was all over the place. Now all kinds of idiots, speculators and geniuses started taking loans. % CRA was now smaller compared to all the new kinds of idiot loans et al. You are the resident genius. Let me know What do you think happened. And remember this paper that Noah mentions talks about how bad were the CRA and other such loans. You must understand for a model to break all it takes is a few standard deviation changes in bad loans compared to the last 50 years of history. The final cause of the crisis more or less looks like a large and sudden NGDP drop of 5-10% range.

As I said you seem to almost avoid talking about the fact that the point under discussion is the initial stages that lead to the crisis. You are not going there for some reason. Maybe you are afraid of what you might find out.

This is anyway the "secretly" accepted theory by top "non-partisan and non raving mad" Economists. But comes under the "politically incorrect" cannot discuss section. The first guy to put this theory was Raghuram Rajan. Also the first real NON WOLF crying guy to predict this crisis. Okay! Maybe putting a big name works. There are enough references and data you will need from his book and other work. But that data cannot be seen by liberals. They are known to go blind when shown such data. Observe evidence here too. Just like they were blind to his prediction TWO years before the crisis. He was also accurate in seeing the SCALE of the crisis. But Hey I like to think maybe someday the blindness will go away.

You see Why I said data does not really matter to folks like you. Once you see the data your head says Correlation is not causation. After someone says no data ever proves causation. It is only supplementary evidence. Its logic and history that tells us a lot more. You say Oh Well then Bush caused it. But suddenly you see a paper with a graph that suits you! Hey! There this proves everything that is in my small little mind!! Eureka!

Eureka Indeed. Good Luck for the next crisis this thinking brings. Its always going to be fun.

Dude, you're the exact kind of person who's unable to understand causation that forces everyone else to repeat "correlation doesn't equal causation". Correlation doesn't equal causation because if there's a single force that drives both A and B, then A and B will end up being correlated. And them someone like you shows up to insist that A causes B.

The evidence is just as strong that the Bucs winning the Super Bowl caused the financial crisis. Why are you ignoring the evidence? Doesn't the data mean anything to you? There were lots of dominos, but Super Bowl XXXVII was the first domino. There are idiots on both sides -- both Bucs fans, and non-Bucs fans. And there are those of us who believe the data -- Jon Gruden did it.

Data does not matter without a concrete theory. This citisism against pure empirisism was as valied when levied against Keynesians as it is when levied against libertarian ideas. I can give you a whole bunch of scenarios that are consistent with the findings of the NBER study and do not put the burden on the CRA.

Causation is not a single track field. We are talking about setting up the stage here. As I have repeatedly mentioned a lot of things were NECESSARY conditions for the crisis. Going upto the final drop in NGDP which can be reasoned to be due to identifiable real factors. So if you think I'm saying the government push to substitute their failure to generate employment by doling out cash through innovative means was the ONLY factor then PLEASE read again. That set the stage for all the other NECESSARY conditions. A simple government push for their favorite idiots ALONE without the other changes they made was not enough for the crisis.

The point is after the government policies if only their favorite IDIOTS got loans and no one else then nothing may have happened. But the history of EVERY single government policy is the story of UNINTENDED CONSEQUENCES. To try to fix one problem for their favorite vote banks they set up an entire chain of events which they did not actually INTEND while designing their imaginative schemes.

But Hey! I agree the government did have NOBLE intentions. But also exactly the reason to be paranoid of more such NOBLE intentions. The next one coming - Obamacare. VERY NOBLE INDEED. Guess what comes next.

Yes you are right. Without governement-built roads there would be no deaths due to car accidents. The government indeed set the sage for everything bad, no more highways please, let them cruble. Now that I see the light, thanks to the genious above, I am off to lunch. Enough troll-fighting for one day!

Sort of a desperately wrong analogy. Till government just stays out and/or makes things for EVERYONE all is good. But when it starts building roads only for a certain bunch of people, starts allocating certain portions of roads to certain disadvantaged sections, buying them cars they cannot afford etc etc then you can get trouble on the highway too. And we are talking of the high street of finance here. In Finance people can ONLY look back to see where to go ahead. There is nothing ahead to see while driving here. AND SO when there is an accident here it is always going to be a BIG one.

Yes. Laughing at your own jokes is supposedly a good way to de stress. Especially after a bout of cognitive dissonance. It works well to get your brain back to its original level of understanding or confusion whichever way you like it.

And the answer to your question is Yes. Anything which is a public good and people have the freedom to use it reasonably freely then sure Why not. But I think that will have to be ONE BIG CAR. But surely there are opportunity costs, the same money could be used to build better things.

Dude Stop kidding yourself. It is ok. We are all biased in some way. But most people give data some respect even when it challenges their bias. But not the low IQ liberals. The argument started with the data in the paper. When you did not like what the data was saying you said Oh Well the data is only for 1999 to before the crisis. Once you realized an 8 year period exactly prior to the crisis matters especially because of the special expanding of laws by the Clinton government to ease all sorts of lending you cried Well Correlation is not causation.

I mean how can you even keep a straight face with that kind of obvious bias in your heads. No correlation 100% proves any causation. We all know that. But each piece of strong evidence increases the possibility of causation. In the end you look at more history, use your logic and begin the see the world for what it is. Not what you want it to be. You want to think of the world as the rich being greedy and wanting to break laws all the time. You do not want to see the world as simply people's natural responses to the laws the Government makes. You do not want to think Government's interference with the natural order as being bad for the long term. You want to live in Utopia because that is all that your brain allows you to comprehend. And I completely get that. It's ok. There is not much people at your IQ level can do anyway.

Stating one factor can’t explain a complex socio-economic phenomenon is stating the obvious. Similarly, the distinction made between a solvency crisis and a liquidity crunch is pointless as they’re much the same thing (rather the liquidity crisis and associated crisis of confidence led onto a credit crunch).

As for the references to what markets should do, efficient or otherwise, so what, lets stick to what they did and do do in practice. Similarly, the chat about mispricing risk also misses the point; risk was wrongly assessed in the first instance (by the rating agencies) and on the basis of this “mispriced” i.e. the process had very clear steps/causal factors and was integral to the “market” at the time.

No idea about the CRA seeing as I’m Scottish and living in Scotland, all I know is US rating agencies handed US investment banks what looked like a means of turning base metal into gold, but turned out to be short-lived turd polish. This was so appealing US investment banks set up shop doing sub-prime equivalent lending here in the UK. So again no idea why the CRA matters here/is in any way at fault.

Back to the role sub-prime RMBS played – banks all over the world bought them (And Alt-A). Based on my own experience working in banking , what happened in the Autumn of 2007 was (1) no one had a clue how big a hole they would eventually blow in bank balance sheets across the world, including the dull German Landesbanks that set up Dublin based teams to buy US RMBS dreck, because they’d suddenly transmogrified from “AAA” into god knows what and (2) uncertainty about sub-prime then called into question the value/risk attached to a growing list of assets i.e. like when monoline wrapped bonds started getting called the next sub-prime or there was the chat about LBOs, sell down debt and PIK notes.

So to be clear sub-prime was the initial catalyst for the destruction of confidence bank solvency/liquidity depended upon. Then Lehman happened.

But I don't think the ratings agencies mis-rated the paper, they were paid off to misrated the risk, a child knew the risk, they were paid off to rate the paper in spite of the know result.

Can't find the link now, but I remember an e-mail from the FCIC hearings from a rating firm that basically said: "I hope we are all rich and retired before we go to jail". They knew it as well as the bankers.

I don't agree. If a child knew the risk then how come the buyers or insurers of the paper, many of them quite sophisticated financial institutions, bought it anyway? And the rating agencies suffered a big drop in their prestige as a result, so at least in the long run the mis-rating did not pay off. It would have paid off even less if the government had not practically created an oligopoly in the rating-agency market.

Of course it didn't. But that hardly cuts against the idea that there was collusion between the ratings agencies and the securitizers. Indeed the creators of the product used high powered lawyers to intimidate lowly agency employees into giving the AAA stamp they coveted because it meant a sure and easy sale. How you can implicate the government is a little baffling.

They never audited all the loans because they felt that tranching and relying on past behavior was adequate. In retrospect that was a mistake, but at the time it may not have been as clear.

This is not to say that the fact that the issuers of a bond pay for the rating may not create perverse incentives. At the same time, the agencies need to balance pleasing their customers with maintaining their reputation, without which they wouldn't have customers Who would bother to obtain a rating from an agency that is not respected by bond markets? Of course, their agencies would care more about their reputation if there was more competition. Unfortunately, the government has created an opligopoly by assigning the status of "Nationally recognized statistical rating organization". Since only three agencies were NRSO according to the government, collusion was easier. I think the SEC should seriously consider making the entrance of rating agencies in the market easier!

By going through the article it is clear that mortgage lending is not financial crisis. the same sort of services is provded by many service provider by providing mortgage with low risk or without risk.one of the service provider is Hamilton Rowe.

Risky mortgage lending -- and indeed, fraudulent mortgage "lending" in many cases -- was *fraudulently misrepresented* as "AAA bonds" by certain bankers for the purposes of their own profits. They also appear to have been running frauds in several other directions.

If you've been following Naked Capitalism for a few years, or read any Bill Black, you'll realize that criminality was epidemic in certain "banks" like Countrywide, and it spread to all of the megabanks.

Noah, You might be knowledgeable on econ, but have missed items to consider & are short on facts about mortgages, relative to the "bubble crash," which you avoided. The fact that the CRA had no major problems for 30 years is insignificant & inapplicable (ceteris paribus? hellno!).

Mortgage rates continued to inch lower on average after rising to the maximum points since September at the end of previous week. There were no significant market moving proceedings following the move, but rather, rates markets are simply consolidating after last week's fast-paced changes.mortgage rates